Competition helping college-savings plans

As the college-savings program known as 529 becomes of interest to more parents, a report released Thursday ranks the best and worst among the nation's tax-advantaged plans.

Competition among 529s has increased the quality among the savings accounts and reduced costs, according to the report by Chicago-based Morningstar Inc., which ranked 529s in Colorado and Maryland among the top.

Illinois was not included in the report, which identified only the top five and bottom six programs. Parents can choose a savings plan in almost any state, whether or not their child plans to attend school there.

The report noted that the best plans couple solid financial performance with low costs, and lauded plans that allow a wide variety of options for parents choosing among investments. Since 2004, when Morningstar began doing the survey, 529s in Utah and Virginia have been mainstays in the top five.

The 529 plans allow parents to save money for their children's future college costs. Parents contribute after-tax income into managed accounts and can withdraw the money--strictly for college expenses--without having to pay federal taxes on the earnings. Originally set to expire in 2010, Congress bolstered the plan last year when it passed legislation to make permanent the federal tax breaks.

To provide an incentive for parents to invest in their home states, many, like Illinois, offer state income tax deductions.

Though Illinois has three different 529 plans, none were among those ranked by the Morningstar report. Illinois' 529 plans have a $10,000 annual cap on contributions eligible for an Illinois income tax deduction. The fee charged for the state's BrightStar program is 0.99 percent, according to www.savingforcollege.com, a Web site where 529s can be compared.

Many 529 plans have been criticized for their often high costs as parents are required to pay money managers--usually of mutual funds--substantial fees. While many financial advisers praise 529s as an efficient way to compel parents to save for their children's education, critics claim that money-management fees can eat up the majority of the tax-free benefit the programs offer. Some also complain that the enrollment process can be unbearably complex.

"The issue with these plans has always been and continues to be that the expenses are ridiculously high," said Austan Goolsbee, a professor of economics at the University of Chicago's business school. "They are taking away a chunk of your tax benefit in the form of fees."

Goolsbee said he considers a plan expensive if it charges an annual fee approaching 1 percent of assets.

The report said the worst 529 performers continued to charge exorbitant rates and offer lackluster investments. Inthe past three years, Alabama's program has been among the worst performers, while Nebraska made the list for thesecond year in a row.

But, the report remained upbeat about the future direction of plans, noting that in spite of the "occasionally Byzantine disclosure documents and layers of fees," the "529 plans in general have improved over the past few years."

When choosing a 529 plan, analysts say parents should determine what kind of state tax deductions are offered for in-state plans. If there are substantial deductions, it could make it an enticing program for locals.

Some states, like Maine, Kansas and Pennsylvania, offer tax-parity laws, which extend each state's tax deductions to residents who invest in out-of-state 529s. More information about Morningstar's report can be found at www.morningstar.com.